Reinvestment in similar industry schemes
After understanding the larceny possible with the step up in basis, the "reinvestment" scheme is remarkably easy to understand. It stems from the concept of realization, the trick used to postpone paying income tax on the investments of ownership (in contrast to the investments of work, which are valued taxed paycheck to paycheck, and yearly). A quick review: realization is in imaginary leap referring to the time when income is "realized," and thus taxed: thus, the aristocracy can employ realization to shield their income from taxation. So, if a wealthy man owns land that goes up $100 in value, and an average man works and earns $100, the average man is taxed, while the wealthy man says, "I have not realized my income until I sell the land."
What happens, though, when the wealthy man sells his land? Is he taxed then, after being able to put it off for as long as he wants (or forever, using the step-up in basis technique)?
No. He is again protected from taxation, through the trick "reinvestment in a similar industry." The citation for this scheme is Internal Revenue Code Section 1031.
How it works is this: the wealthy man owns his property through a business. Let us say that Wealthy Man A owns Business B, which owns Land C. So, A owns B, which owns C.
C goes up in value $100. B (at the direction of A) then sells C, thereby realizing $100 of gain (the realization scheme relies upon the fiction that income is postponed until the time of sale). Then, A wants to avoid tax, so he has his business use the proceeds of the sale to buy another piece of property: a factory, a building, a farm, et cetera. The "reinvestment in similar industry" rules allow him, if he buys another piece of property like this, to not pay tax yet again.
Why is this allowed? The aristocracy justifies it by arguing that it would "stifle business investment" if the wealthy were forced to pay taxes when they sold property to buy other property, because then wealthy people would refuse to sell property just to avoid having to realize their income, and be taxed. (Of course, the only reason they would have such motivations to hold property in the first place is because of the realization scheme that helps them postpone taxes until sale.)
Thus, the aristocracy argues that postponing tax yet again allows them to buy and sell properties freely (literally "freely," since they are avoiding tax), which helps the economy, which helps everyone. In actuality, it helps the aristocracy to never have to pay tax.
(There are some qualifications to this rule, of course; little technicalities to ensure that only the savvy wealthy whom the scheme is designed for [with lawyers and family wealth planning] can take advantage of it. They are weak qualifications, the strongest being that you have to "reinvest" the proceeds of sale [i.e., buy a new piece of property] within 45 days.)
The larger effects of this theft can be staggering when the reinvestment in similar industry provisions are combined with the realization provisions and the step-up in basis. Here's how it works:
1) The realization provision allows you to postpone paying income tax until a property is sold;
2) The reinvestment in similar industry ("like-kind") provisions allow you to postpone paying income tax even when you sell a property, as long as you buy another property within 45 days;
3) The step-up in basis provisions allow you to eliminate any income tax inherent in an unsold property whenever a wealthy owner dies.
Can you see where this is going? What this system amounts to is a pass to the wealthy against ever paying income taxes at all on their greatest pieces of property. All the wealthy need to do is hold property, watch its value rise, and enjoy the increase in their dynasty's net worth. As long as they wait until the death of a family member, and distribute ownership interests accordingly, the step-up in basis protects each generation from ever paying income tax. And, if they ever want to sell a property without waiting for a death, they simply have to find another noble family in a similar predicament, and switch properties.
This is much of what commercial land deals are: "businesses" (owned by the wealthy, through trusts or other businesses) such as commercial real estate, apartment buildings, etc., being switched back and forth between different dynasties, who each use the transaction as a justification for bringing in IRC 1031 and canceling out any income tax on all the gain they got from the increase in their property's value.
On paper, it seems like two (or a dozen, in a big, happy circle) different businesses are making different investments for the purpose of profitability and bolstering the economy. In fact, the nobility is playing hide the pellet, and is exchanging the properties primarily to wipe out income tax without using the step-up in basis at death. With each new transaction, income is "deferred," and the dynasty can buy and sell and move whatever it wants without tax, until finally someone dies, and the step-up in basis frees up the next generation to do the same thing, without ever paying its fair share to the rest of the country.
Entire industries within the legal, financial services, and property appraisal fields have sprung up to serve these transactions, by generating official-looking paper trails, earning fees, and ensuring that the wealthy families fairly compensate one another for the properties they switch between their respective businesses and trusts. But, the money spent on these middlemen is nothing compared to the vast amounts stolen from the body politic through these overlapping tax schemes.
Succeeded in Part 5.